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Markets & Economy

Four pillars for investing success

May 23, 2014

Rebecca Katz: We are talking about something tonight that is very near and dear to all of us here at Vanguard, and we hope that it is also near and dear to you. That is Vanguard's principles for investing success. And those principles are: goals, balance, cost, and discipline.

Because we are owned by our investors—we're owned by you, our investors—we have always stood as advocates for our investors. And I think that that is best articulated in these investment principles; they're four pillars that you can use as a guide to meeting your financial goals.

Rebecca Katz: I thought maybe, Kahlilah, we could start with you, and you could take us through kind of our first principle, which is really about identifying goals, something I'm sure you do every day, day in and day out, as a financial planner.

Kahlilah Dowe: Yes, yes I do. Identifying goals. That's really the first step that you're going to take when you start to think about what should my portfolio look like. And it's really exciting because you kind of get to ask yourself questions around what will this money be used for. So it could be retirement, it could be purchasing a new home, it could be college planning—but you want to make sure that you have a very clear vision for what you'd like to use the money for some time down the line, because you're going to have to come back to that when you start to think about why do I have the funds that I have in my portfolio.

Rebecca Katz: And you may have many of those goals at the same time, correct?

Kahlilah Dowe: That's exactly right. So you may have several goals that you're investing for, and you may have different risk tolerances for each of those goals. That's one of the things that you'll also look at when you think about what your portfolio should look like. So how much risk am I looking to take in my portfolio? And that in part will depend on the nature of the goal, right? So if it's a retirement goal, perhaps you could be far more aggressive if it's a lot further out; whereas if you have a goal that's more, let's say short-term in nature, where you're going to purchase a home, let's say within the next five years, then you may look at being more conservative with that.

Rebecca Katz: Sounds like you have to do some self-assessment up front.

Kahlilah Dowe: Yes.

Chris Phillips: I think it is one of the big questions out there, and at the end of the day, when you think about what the second pillar of our principles actually is, it is balance, it is diversification, it is setting that asset allocation to meet the objectives that you've outlined with that first one.

Rebecca Katz: So what makes it so hard?

Chris Philips: A lot of the problem comes with just identifying—selecting the assets that you want to best achieve the goals that you've outlined. And there's so much noise in the marketplace, whether it is the daily newsfeed that we see out there on the TV or the internet; whether it is all the differing perspectives that we hear, whether it's from economists or market strategists or your neighbor or your friend, all these things compete for air time in our own brains, and it can make it that much more difficult to actually set something that aligned with your perspective, and meets your objectives down the line.

Rebecca Katz: And, Chris, you talked about balance, we talked about goals, so the third pillar is cost. So how do we think about costs? Obviously we are the at-cost fund company. But what is that? Why is it so important?

Chris Philips: Cost is something that is directly in your control as an investor. So when you think about trying to achieve returns, going forward, we can hypothesize that stocks might give you X and bonds might give you Y, but what we also know with certainty is that the more you pay, in terms of cost, the less return you're going to get at the end of the day. And that is something that, I'll say it again, I'll say it until the cows come home, that that is something that's directly in your control as an investor. And what we would like to see is more investors keep more of their money.

The challenge with cost is that it is not just expense ratio. If you're using exchange-traded funds—ETFs for those who are in the know—there's bid-ask spreads, so there is additional cost there. There's tax costs over time that you have to be aware of, so there's a whole range of costs that someone needs to be concerned with. The objective of effective financial planning, or portfolio management, is to minimize all those costs over time, so you're maximizing the returns that you can see as an investor.

Rebecca Katz: Really, this does come down to our last investment principle, which is discipline, and I think, Kahlilah, we could turn back to you to talk about discipline. And then, Chris, you had some interesting observations on rebalancing that perhaps you can share.

Kahlilah Dowe: Sure. So the discipline—I kind of look at that as the glue in holding all of this together. So you have your asset allocation in place; you have the funds that are appropriate for your portfolio; and I think the discipline really is important when it comes down to, one, rebalancing the portfolio, making sure that, regardless of what the market is doing, you are sticking with the initial asset allocation that you set—the initial mix of stocks and bonds.

But I also look at discipline when it comes down to your goals. So making sure that you're reviewing your goals, because they change, right? They can. So making sure that if you plan to retire at, let's say, age 50, that that's still the case five years from now, and adjusting the portfolio as you near retirement as well.

I think that in the absence of that discipline, investors are often in situations where you're just loading up on funds based on performance, where you're chasing returns. So you're kind of looking at your portfolio and saying, "Why do I have this fund? It was doing well when I purchased it; it's not doing so well now. Perhaps I should have different funds." So it kind of minimizes the chances of you falling into that pattern.

Chris Philips: And if I could add one point to that, we've done a lot of work at Vanguard around trying to actually quantify what that impact might be. And some of the work that we've done has shown that chasing returns or poor timing of investors making these moves can actually lead to a drag of around 1.5% per year. So what does that mean? That means that if, hypothetically, you expect your portfolio to return 6% in the future, and you are subject to these behaviors, your net return after that is 4.5%. That can be a huge impact to investors over time, which is why it's so important and why that glue is so critical to having effective implementation of a well-articulated plan over time.

Important information

All investing is subject to risk, including the possible loss of the money you invest.

For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Learn about the key components of sound investing

As an advocate for investors, Vanguard has developed four enduring principles to help maximize your chances for investing success. Vanguard experts Kahlilah Dowe and Chris Philips define and explain our four pillars: goals, balance, cost, and discipline.

Other highlights from this webcast:

All investing is subject to risk, including the possible loss of the money you invest.

For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.